Nigerian banks are setting aside more money than they did in the last three years for bad loans amid the coronavirus (Covid-19) pandemic, indicating that the banks see a need to further shore up reserves to weather a wave of defaults.
Analysis of 11 commercial banks including Access Bank, Guaranty Trust Bank, First Bank, United Bank for Africa, Zenith Bank, Sterling Bank, Stanbic IBTC, Fidelity Bank, Union Bank, Wema Bank, and Ecobank shows that the provisions for loan defaults soared by a combined 58.5 percent to N152.7 billion in the first half of 2020 from N96.3 billion for the same period in 2019.
Loans given out by these banks jumped by a combined 19.8 percent to N16.8 trillion in the first half of 2020 from a year earlier of N14 trillion.
In the first half of 2020, combined profits for the banks slumped by 1.99 percent from a year earlier, and combined return on equity fell to 80.34 percent from 92.92 percent for the same period in 2019.
With a combined loan default provision to total loans given out of 0.88 percent, Nigerian banks seem to be showing optimism that the bulk of loans they gave out will not go bad.
Why are the provisions for loan defaults increasing?
Provision for loan defaults is increasing because of the fragile state of the Nigerian economy, which has been hit this year by the twin shocks of Covid-19 and slump in global oil prices.
Nigerian banks are creating higher provisions for defaults given the increased risk in the operating environment.
The economy contracted 6.1 percent in the second quarter of 2020, as the virus took a toll on economic activity.
The Purchasers Managers’ Index (PMI) indicates that Nigeria would sink into its second recession in four years by the third quarter.
Periods of economic downturns affect the cash flow of businesses and tend to lead to higher loan defaults.
Another reason for the jump in the provisions for loan defaults is the adoption of International Financial Reporting Standards (IFRS) 9 in 2018 by Nigerian banks.
Unlike the previous standard that was based on an incurred loss model, IFRS 9 is a more forward-looking standard that emphasises the need for banks to make adequate provisions on their expectations of loans that they project will go bad in the short to long term.
What this means for banks
Increases in the provisions for loan defaults will put a downward pressure on the profits of banks till the end of the year, according to analysts.
This could be a warning sign for the banks that have to continue to give out loans based on the mandate by the Central Bank of Nigeria (CBN) to give 65 percent of their deposits as loans.
“Nonetheless, when you look at the fact that many banks have been taking advantage of the credit facility restructuring approved by CBN, it is possible that Non-Performing Loans (NPLs) for the rest of the year may not reach the height they were in the last recession in 2016,” Gbolahan Ologunro, a research analyst at CSL Stockbrokers, states.
“On a short-term basis, therefore, there is a likelihood of seeing a gradual deceleration of the provisions for loan default to 30-40 percent year-on-year as the economy tries to stabilise as away from the initial impact of twin shocks on the economy,” Ologunro says.
What it means for individuals and businesses
If the banks have to keep increasing provisions for loan defaults, then there is a chance that the number of approved loans will decrease as banks would have to manage their risk exposure.
The Credit Conditions Survey Report for the second quarter of 2020 reveals that banks are already tightening their credit scoring criteria and as such saw a surge in the credit available to households and corporates.
“With the dwindling purchasing power of Nigerians, records of losses and decline in revenue by several businesses, the tightening of credit scoring criteria to reduce loan defaults will negatively affect individuals and businesses alike,” notes Wale Olusi, head of research, United Capital.